Active managers win this round — barely

Active equity managers have long been criticized for not living up to the fees they charge and rightly so based on numerous studies and countless statistics over the years that show passive investing is a more profitable, more reliable way to make money on equity markets

Active equity managers have long been criticized for not living up to the fees they charge, but the latest quarterly study from Russell Investments Canada suggests that may not always be justified, although it doesn’t quite go far enough to refute it entirely.

“In the most recent four quarters, an average of 83% of large cap managers beat the benchmark with the median manager return ahead of the benchmark by roughly 150 basis points on average,” said Kathleen Wylie, Russell’s head of Canadian equity research, in the report.

“The last time we experienced four consecutive quarters in which large cap managers beat the benchmark was the second quarter of 2007 and overall that environment was not nearly as strong as what we’ve seen this time.”

The study, which is based on recently released data from more than 150 Canadian institutional equity investment manager products, showed that at least 50% of large-cap managers in the country have outperformed the S&P/TSX Composite Index in seven of the past 14 years.

The best years during that span were between 2000 and 2002 when more than 80% of active managers did better than the index, followed by 2012 when 76% beat, making it the best year for active stock investing since 2002.

The worst year was 1999, when 73% of managers underperformed the benchmark, largely because of the weight of Nortel Network in the index.

More recently, the two years following the financial crisis were also tough on active managers. In 2010, only 36% beat the index and only 42% did better in 2011.

Ms. Wylie said several factors negatively impacted active management performance in the aftermath of the financial crisis, including the increased weight of resources, particularly gold stocks, in the S&P/TSX Composite, volatility spikes and stock correlations that were driven by a focus on macro and/or geopolitical factors.

Perhaps more importantly, the study also showed a marked improvement in the amount of alpha — or excess return — above the benchmark that active large-cap managers have been able to obtain.

In 2012, the median manager return was more than 200 basis points higher than the benchmark. This year, the advantage is 155 basis points to date.

But over a 10-year period, the average outperformance is far less impressive at 18 basis points, especially considering the returns quoted in the study are not net of management fees.

Fees for active equity funds can be 1% (100 basis points) or higher than fees for index-tracking exchange-traded funds, thus a passive investment in Canada’s top benchmark is generally more profitable over the long run.

Yves Rebetez, managing director and editor of ETFinsight in Toronto, said the most important measure for investors isn’t whether active managers add value in a particular quarter or even a series of quarters, but rather what they as a group ultimately deliver over longer periods of three to five years.

“With trends generally well in place — that is, materials are challenged, particularly gold — beating a currently handicapped benchmark has probably been rendered a little easier,” he said. “When you look at this longer-term horizon, the ability of the majority of managers to outperform disappears almost entirely. And fees don’t help, naturally, versus ETFs.”